Your income taxes are due on April 18. What should you do if you can’t pay what you owe?
File your tax return
First and foremost, even if you can’t pay, you should file your tax return on time. The penalties for not filing a return are severe: 5 percent per month on the amount you owe, to a maximum of 25 percent reached after five months.
This is in addition to the interest the Internal Revenue Service charges for paying your taxes late. Filing your return — even if you can’t pay what you owe — will at least avoid this penalty.
Borrow the money
The interest rate on a loan or credit card may be lower than the combination of penalties and interest imposed by the IRS. As a result, it could be cheaper to borrow money or use your credit card to pay what you owe.
You could try borrowing the money from a friend or relative, obtain a personal loan from a bank, or take out a home equity loan (assuming you have a home with equity). Using credit cards to pay should be a last resort since the interest is usually high.
If you can’t get together enough money to pay all you owe, at least make a partial payment. The penalty for not paying your taxes on time, even though you filed a return, is smaller than that for not filing at all, but it’s not negligible.
The IRS will charge you 0.5 percent per month on the amount you owe, to a maximum 25 percent reached after 50 months. You’ll avoid at least a part of this penalty by making a partial payment when you file.
Request an installment agreement
Consider asking the IRS to permit you to pay what you owe over time in installments. If you owe $25,000 or less in combined taxes, penalties, and interest, you should be able to get an installment payment plan for up to 60 months just by asking for it.
You can apply online at the IRS website. However, if IRS computers show that you haven’t filed all past due tax returns, you will not be eligible for an installment plan. Likewise, if, like most real estate professionals, you are self-employed, you must be current on your quarterly estimated tax payments for the current year.
If you owe more than $25,000, you will have to negotiate with the IRS to get an installment plan. You may also have to submit a financial statement.
Unfortunately, interest and penalties continue to accrue on your unpaid balance while you make your installment payments.
Seek an undue hardship extension
You can get an extra six months to pay the amount you owe by obtaining an undue hardship extension from the IRS. During this time the IRS won’t charge you any penalties, but you’ll still have to pay interest on the amount you owe.
You can get this extension only if you convince the IRS that paying your taxes on time will result in "undue hardship." Undue hardship means more than an inconvenience. You must show that you will have a substantial financial loss — for example, you’ll have to sell property at a sacrifice price.
If you have assets, you’ll be required to provide security for your tax debt — for example, a bond, deed of trust, notice of lien, or personal guarantee.
To obtain a hardship extension, you must file IRS Form 1127, Application for Extension of Time for Payment of Tax Due to Undue Hardship, and provide detailed financial information.
Make an Offer in Compromise
If you have already filed your return, but are unable to pay your taxes, you have another option: making an offer in compromise (OIC), which the IRS describes as "an agreement between a taxpayer and the IRS that settles the taxpayer’s tax liabilities for less than the full amount owed."
The IRS, like most creditors, would rather get something than nothing. Thus, you may be able to convince it to wipe our your entire tax debt if you pay a part of what you owe.
In some cases, the IRS has accepted as little as 1 percent of the amount owed on a tax bill. However, the IRS doesn’t have to accept any OIC, and fewer than half are actually accepted.
The IRS will accept your OIC only if you convince it that:
- You aren’t able to pay the full amount;
- There is doubt as to the amount of your tax liability (unusual); or
- Due to exceptional circumstances, payment in full would cause an "economic hardship" or be "unfair" or "inequitable" — for example, you can’t work due to health problems, or you’d be left with no money to pay your basic living expenses if you sold your assets to pay your tax bill in full.
Moreover, the amount of your offer must be equal to the "realizable value" of your assets plus the amount of money the IRS could take from your future income. For example, if your assets are worth $20,000 and the amount of your future income that’s available to the IRS is $10,000, your minimum offer must be $30,000.
To begin the OIC process, you must file IRS Form 656, Offer in Compromise and pay a $150 application fee. You must also make detailed disclosures about your finances on IRS Form 433-A, Collection Information Statement for Wage Earners and Self-employed Individuals. See the IRS website for details.
